The Benefits
The benefits of investing in frontier markets are many:
- The aforementioned low correlation with other markets is a strong selling point. The factors that sway frontier markets are not necessarily the same factors that would sway a developed market.
- There’s simply more potential and room for growth. Frontier economies are simply starting out with less than other larger economies.
- They offer diversification. Not only is the correlation low, but frontier markets can be another area to invest that will help you fine-tune the international exposure your portfolio has.
The Risks
Make no mistake: though there’s great potential in these small but fast-growing economies, there is great risk. Frontier markets are young economies with unique problems that need to be weighed carefully.
- Country risk, or the economic, political and business risks unique to a specific country or region, might result in unexpected losses. Emerging and frontier markets are in the midst of rapid industrialization and provide higher levels of growth, which may result in higher investment returns. But this greater political uncertainty often results in more frequent booms and busts. Before you invest, you should consider an emerging market’s economic and financial fundamentals and political climate.
- Economic risk is a country’s ability to pay back debts. Countries with stable finances should be able to withstand economic shocks better than weaker or unsound economies. One way to determine a country’s ability to repay debt is through ratings agencies like Moody’s, Standard & Poor’s, Fitch or other large ratings agencies. Countries with higher credit ratings are considered safer investments as compared to those with lower ratings. Additionally, one may scrutinize a country’s gross domestic product (GDP), inflation and consumer price index (CPI).
- Political risk refers to the political decisions made within a country and the possible unanticipated loss that may result. Frontier and emerging markets often have corrupt governments or the kind of political infighting that hinders or stalls growth altogether.
- Social risks may also be seen through potential wars, famines or diseases that could ravage a frontier market. Needless to say, such occurrences would impede the natural growth of an economy by sucking away necessary resources for the further development of a country.
Frontier Market ETFs
Despite the risks, investors appear to be increasingly willing to overlook them and explore the potential these markets have to offer. They’re interested in these regions because of their potential for developments in infrastructure, commerce and modernization. Countries such as China and Brazil were once labeled frontier markets, and they’ve produced some hefty gains in the past decade.
ETFs are a very easy way to give your clients exposure to frontier markets. Researching corporations in these countries can be very difficult when you consider that many of them may not have the same reporting and transparency requirements asked of companies in developed countries. ETF providers and index creators do a lot of research into these markets and their choices for index components are heavily monitored and vetted.
Here are a few tips to get you started:
- One of the risks of frontier market ETFs is that since these markets are less liquid, the funds can themselves be low on liquidity. This creates wide bid-ask spreads. As you’re buying, be sure to watch the spread and use limit orders instead of market orders to control what you pay.
- Consider the level of exposure and risk that you and your clients are comfortable with. There are single-country frontier market ETFs such as Market Vectors Vietnam (NYSEArca: VNM) or iShares MSCI Thailand (NYSEArca: THD). Broad funds, which allocate assets in multiple countries, include Guggenheim Frontier Markets (NYSEArca: FRN) and PowerShares MENA Frontier Countries (NYSEArca: PMNA) are examples.
- Use the alerts tool to be notified of trading opportunities in these ETFs. Sentiment in frontier markets can shift quickly. By having alerts in place, you won’t miss a key event.
With a solid strategy in place and a firm understanding of the risks and rewards, you just might find that the fruits of frontier market investing can be sweet.